The European Union’s highest court has ruled that Denmark’s withholding tax rules for foreign Ucits funds are contrary to EU law in a case brought by Fidelity.
The ruling comes as the Danish government plans to level the playing field between the taxation of foreign and local funds in a move that could open the retail market to cross-border firms.
Non-Danish Ucits funds are currently subject to a withholding tax of 27 per cent on the dividends distributed by Danish resident companies, which locally based funds do not pay.
Fidelity International originally brought a claim on behalf of three funds domiciled in Luxembourg and the UK to refund withholding tax before the Danish national courts.
The claim, which was supported by Dutch firm NN Investment Partners, was referred to the ECJ by Denmark’s Eastern Regional Court in June 2016.
In a preliminary ruling published on December 20, the European Court of Justice says the Danish tax regime is contrary to EU law on the free movement of capital.
The ECJ ruling determines applicable EU law, but the final legal ruling remains with the Danish court.
A spokesperson for Fidelity says: “This deduction of tax is contrary to EU law and we would like to recover what we feel is unfair withholding tax charged.
“This is simply for the benefit of the funds and their investors and if successful we would return this to the funds themselves.”
The ECJ case was a “driver” for the government’s recent decision to put forward its plans to end the tax discrimination against foreign funds, says Rodolfo Crespo, senior analyst at consultancy Platforum.
The initial proposals, for which there is “little detail”, will now be worked on by the Danish ministry of taxation. The next step is for a bill to be proposed, which the government then plans to enact in 2019.
Experts say the proposals have the potential to open up the Danish retail market to cross-border funds for the first time.
Foreign funds sold into Denmark account for less than 8 per cent of the market, according to Broadridge data. Cross-border funds are primarily invested into by Danish institutional investors, for whom there is no difference in the tax treatment of local and foreign funds.
Jesper Frøkjær, Nordic head of wealth and asset management tax at consultancy EY, says the Danish government wants retail investors in non-Danish funds to be subject to the same level of taxation as local funds.
There is agreement between political parties that the use of cross-border funds will help create “stronger competition” in the Danish market, says Mr Frøkjær.
“I definitely expect it to be a significant change, although it will also depend on how the Danish ministry enacts the change in the law. I expect it to tear down barriers,” he says.
Mr Crespo agrees, saying Denmark has been “highly criticised because of its unfavourable taxation on foreign funds”.
“The implications [of changes in the law] for international asset managers could be significant,” he says.
Kasper Svendsen, head of tax policy at Finance Denmark, the trade body, says: “Entry to the Danish market will be easier [for foreign funds] since the proposal is intended to create a level playing field from a tax perspective.”
However, before the government bill is put forward it is “a bit premature” to make predictions on their significance, Mr Svendsen says.
Peter Preisler, former head of Europe, the Middle East and Africa at T Rowe Price, says the changes will have a “slow-burning effect” for foreign funds.
Mr Preisler says local banks’ domination of retail fund distribution in Denmark means the benefit of the rule changes for foreign active fund managers “will take a long time”.
He adds that some local firms, including Danske and Nordea, offer white-label funds where foreign managers act as sub-advisers, providing another route for international firms to access the Danish market.
Exchange traded funds are expected to benefit from the Danish government’s plans more quickly, however.
“The government specifically mentioned ETFs as a big reason why it is getting involved,” Mr Preisler says.
“There is certainly the potential for them to play a bigger role.”
Mr Frøkjær agrees, saying Danish politicians are looking to support “lower-cost products”.
Less than 4 per cent of Danish fund assets are in passive products, according to Broadridge data.
The government plans also include an exemption for foreign investors from dividend tax on Danish equity funds.
The aim of this proposal is to attract foreign capital to local products.
Mr Preisler disagrees with those in the local industry who believe this will create a “big opportunity” for Danish funds to compete in other markets.
“History shows you can only really use Luxembourg or Irish funds in other markets,” he says.
The Danish ministry of taxation declined to comment as the ECJ’s opinion is a preliminary ruling. NN Investment Partners declined to comment.
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